Tax Lawyer Blog

A Blog written by the Tax Attorneys for Individuals and Businesses

Calculating Gain from Reimbursement for Loss of Personal Use Property

The proceeds from my insurance coverage were more than the adjusted basis of the property I lost but less than the fair market value. Does that mean I can't take a tax deduction?

Yes. Although the fair market value of the property may have been more than your adjusted basis, you don't have a loss for tax purposes. In fact, you have a gain and need to consider the tax treatment of that gain.

What rules apply to gain resulting from insurance proceeds due to loss of my main home and/or contents as a result of a disaster?

There are several special rules, which apply to renters as well as homeowners.

First, no gain is recognized on any insurance proceeds received for unscheduled personal property that is covered in your primary insurance, but is not specifically itemized or valued. These items do not warrant specific insurance and are usually associated with the original policy. An example of “scheduled personal property” not included in “unscheduled personal property” is valuable jewelry.

Second, any other insurance proceeds received for your main home or scheduled personal property are treated as received for a single item of property. You can postpone recognizing that gain for tax purposes by purchasing replacement property that it similar or related in service or use to the home or its contents and that has a cost equal to or greater than the insurance proceeds you received.

Third, if the insurance proceeds exceed the cost of replacement property, you have to recognize gain only to the extent of that excess.

I have a gain from insurance proceeds I received from the destruction of my main home. How long do I have to purchase replacement property in order to postpone recognizing any gain?

To postpone the gain, you must purchase replacement property (another home and/or its contents) within four years after the end of the year in which you realized the gain. You must reduce your basis in the replacement property by the amount of any postponed gain. You will be treated as having owned and used the replacement property as your main home for the entire period you owned the destroyed property. This will be important in determining the tax treatment when you dispose of the replacement property. Also note that some or all of the gain may be excludable, meaning no federal income tax will ever be levied upon it and it does not need to be postponed. See question and answer 7 below.

For example, if your main home had an adjusted basis of $100,000 and you received $150,000 in insurance proceeds when it was destroyed, you have a tax gain of $50,000. You may postpone all of this gain by purchasing a replacement home (including contents) that costs at least $150,000 within four years. Your basis in the replacement home would be its cost less $50,000, the amount of the postponed gain. If your replacement home does not cost as much as the insurance proceeds, your tax gain will be limited to the excess of the insurance proceeds over the cost of the replacement property.

To postpone the gain, do I have to use the insurance proceeds to purchase the new property or can I take out a mortgage?

As long as the cost of the replacement property exceeds the insurance proceeds, you can use funds from any source, including a mortgage, to purchase the replacement property.

How do I elect to postpone the gain?

To elect to postpone the gain, you must attach a statement to your tax return for the year in which you have the gain. The statement must include the date and details of the disaster, the amount of insurance or other reimbursement received, the calculation of the gain being postponed, and it must say that you are electing to postpone the gain by purchasing replacement property. Then for each year during the replacement period in which you purchase replacement property, you must attach another statement to your return containing information about the replacement property. Your Tax Attorney can explain the election procedure in more detail.

What happens if I don't actually replace my property within the four-year period?

If you do not replace your property within the required period, you will need to file an amended return for the year in which you received the insurance proceeds from the disaster to report the gain. If you purchase replacement property but it costs less than the amount of insurance proceeds, you will need to file an amended return also for the year you received the insurance proceeds, but the gain will be limited to the excess insurance proceeds.

Instead of the special rule described above, can I just treat the insurance proceeds I received on the loss of my main home as if it had been sold for that amount?

Yes. Under the normal rules that apply to gain from the sale of a main home, you may exclude a maximum of $250,000 ($500,000 if married and filing jointly). If your gain is more than you can exclude under the normal rules, you can postpone reporting the gain by buying replacement property, as described above.

The California wildfires destroyed my vacation home and I received insurance proceeds in excess of my adjusted basis. Can I elect to postpone that gain?

Yes. However, the replacement period ends two years after the end of the year in which the gain is realized. The special four-year replacement period described above applies only to insurance payments received for the loss of your main home.

Claiming Disaster Loss Deductions for Personal Use Property

How do I calculate my disaster loss?

Take the lesser of the adjusted basis of the property, or the decrease in fair market value due to the disaster, and subtract any insurance or other reimbursement you received or expect to receive. For example, if a home with an adjusted basis of $80,000 and a value of $120,000 was completely destroyed and the owner received $70,000 in insurance payments, the owner's disaster loss would be $10,000. This is determined by taking the adjusted basis ($80,000), which is less than the decrease in fair market value ($120,000), and subtracting the insurance payments ($70,000). We can help you with this calculation if needed, especially since most people are unsure just how much they will receive from insurance or a lawsuit.

If I have not yet filed an insurance claim, can I count the whole loss to figure out my tax deduction or do I have to count the insurance payments that I expect to receive?

When you calculate your disaster loss, you must take into account the amount of insurance payments or settlement from a lawsuit that you expect to receive, whether or not you have filed a claim. If you later receive less insurance money than was expected, you may include that difference as a loss for the year in which you expect no further insurance or other reimbursement. If you choose not to file an insurance claim, your disaster loss can not exceed the amount of your insurance deductible.

How do I decide whether it is better to take the disaster loss in the year of the disaster or in the prior year?

This is an important question. Your tax attorney should calculate the tax benefit both ways and see which is greater. Also consider the time value of money and other factors on both year’s tax returns. Since the disaster loss is deductible only to the extent it exceeds 10% of your adjusted gross income, it may be smarter to claim the loss in the year in which your income is lower. You will need to itemize deductions (instead of claiming the standard deduction) in order to claim the disaster loss deduction.

How long do I have to decide whether to claim the disaster loss on an amended return for the prior year?

You must make this election to take your casualty loss for the disaster in the preceding year on or before the date that is six months after the regular due date for filing your original return (without extensions) for the tax year in which the disaster actually occurred.

How do I determine the reduction in my property's fair market value?

The best way to determine the reduction in your property's fair market value is to have a professional appraisal. If you had an appraisal done to secure a federal loan through the federal disaster program, you can use that appraisal. Choosing the appraiser is very important because the appraisal may be challenged by the IRS and defense attorney in a lawsuit. Your attorney may be able to refer you to a qualified appraiser.

Does the cost of the appraisal get added to my loss?

No. The cost of the appraisal is considered a “miscellaneous itemized deduction” and may be deducted, with other miscellaneous itemized deductions, only to the extent that they exceed 2% of adjusted gross income. However, it would be added to your list of damages in a lawsuit.

I don't own a home but my rental residence and its contents were destroyed. Can I claim a disaster loss for personal property even if I did not own a home?

Yes. The disaster loss rules for renters are the same as for homeowners. Once you determine the lesser of the adjusted basis and the decrease in fair market value of the property, you then subtract the amount of insurance proceeds to determine the amount of the disaster loss. If you do not have any insurance, just skip that step when you calculate your loss.